Small Business

Bankruptcies on the Rise

More businesses filed for bankruptcy in April, 2008, than in any month since new bankruptcy laws took effect in 2005, according to a company that tracks federal court filings.

The numbers show a 49% increase in commercial bankruptcies over last year, with an average of 235 daily filings last month compared to 158 in April, 2007, according to data compiled by Jupiter eSources, an Oklahoma City company that runs a database called Automated Access to Court Electronic Records(AACER). More than 5,000 firms filed for bankruptcy in April, 2008, the most in any month since the new laws took effect in 2005.

That leap in bankruptcy filings shows the troubles that started with sub-prime mortgages and other financial instruments on Wall Street have hit home for small businesses, according to one economist. "Last year was too early to really see the problem for normal-type firms. The only people having trouble last year were hedge funds and big banks in New York City," says William Dunkelberg, chief economist at the National Federation of Independent Businesses (NFIB). He adds that companies that survived at the margins in good times are likely to be wiped out during a downturn: "Recessions always used to clean up the inefficient firms, and that's what we're seeing."

A combination of tighter credit, higher commodity prices, and stagnant sales likely accounts for the rise in bankruptcies, experts said. Builders and other businesses tied to the housing market likely account for many filings.

Turning to Out of Court Resolutions

It's unclear how much bankruptcies reflect the overall rate of business failure (BusinessWeek.com, 1/23/08). "Increasingly, businesses over the last 10 years have been turning to out-of-court resolutions for resolving financial distress," says Robert Lawless, a bankruptcy law expert at the University of Illinois College of Law. Companies that have no creditors simply close their doors and are not recorded in the statistics.

AACER records any bankruptcy filed with a taxpayer identification number or a "doing business as" name instead of a Social Security number as a commercial filing, according to Mike Bickford, the firm's president. Those filings include many sole proprietors whose bankuptcies would not be counted as commercial filings under official government records, he says.

Some of those unincorporated businesses—sole proprietors running home-based businesses, for example—may be victims of tighter consumer credit. "Those people don't rely on bank loans. They're using their credit cards, they're using home equity lines of credit," says Lawless, who writes about bankruptcy on the blog Credit Slips. Banks loans are tougher to come by as well. A Federal Reserve survey of senior loan officers at 56 banks showed that more than half raised lending standards for small business borrowers during the first quarter of 2008.

Rising Prices Are Real Culprit

The filings also reflect a shakeout in the housing market. "The number of new builders that opened up shop [in markets like Florida] was huge," says the NFIB's Dunkelberg. "A disproportionate number of these bankruptcies are going to be builders or companies closely tied to the housing market."

Dunkelberg disputes that tight credit has hit small companies; he says rising prices are the real culprit. The share of business owners who listed inflation as their top concern rose to 12% in March compared with 4% the previous year, according to the NFIB's monthly membership survey. Only 2% listed financing and interest rates. "There's still no credit problem on Main Street, but there is an inflation problem," Dunkelberg says.

As rising costs put pressure on margins, many businesses have seen their revenue fall as well. "I'm seeing contraction of the sales," says Cathy Moran, a bankruptcy attorney in Mountain View, Calif., who works mostly with small businesses and consumers. Moran says she has handled recent cases for two construction companies and an engineering firm, along with non-housing related businesses like bike shops and spas. Business failure had been the prime reason clients came to her until about four months ago. "Now it's kind of tipped the other way, so that more often than not bad mortgage loans are the driving force," she says.